They are the newest, hottest thing to hit social media, giving consumers hefty discounts on goods and services. Called group buying services, they also resonate with small to medium-sized local merchants that are attracting customers by offering quantity discounts.

CRM magazine spoke to Groupon and LivingSocial, the 800-pound gorillas in this space that together own 90 percent of the market. While their business models are similar, their philosophies set them apart.

For instance, Groupon (a morphing of “group” and “coupon”) boasts the most subscribers, having created the group buying service business and having offered its first deal—a 50 percent discount on pizzas—in November 2008. Today, the company claims it has 70 million–plus subscribers, serves 45 countries, and runs about 900 deals a day on its Groupon.com Web site (accessible by computer or cell phone) and posted on Facebook and Twitter.

The typical Groupon subscriber is a single, college-educated woman in her late 20s to late 30s who earns more than $70,000 a year with plenty of discretionary income.

A spokesperson would not discuss stats relating to Groupon’s growth other than to say it currently serves “more than 50,000 merchants domestically and hundreds of thousands worldwide. This is such a competitive industry that we can’t say more.”

Here’s how Groupon works: Merchants either approach Groupon or the service seeks out attractive businesses with which to partner. Together, they agree on a deal for a specific date and on a minimum number of people to sign up for the offer. If on that date the predetermined number of customers isn’t met, the deal is canceled for that day, and the merchant pays nothing. If the minimum number of customers is met, the deal is activated and the merchant pays half the revenue to Groupon—in addition, of course, to having lost revenue by discounting the product or service. So, for example, if the consumer pays $25 for a $50 lunch at a restaurant, Groupon and the restaurant split the $25—meaning the restaurant gets $12.50 for a meal valued at $50.

While deals are set on a onetime basis, merchants who enjoy the experience are allowed to become a “merchant partner,” which guarantees several additional deals. Groupon says that 97 percent of businesses either want to run a deal again or would recommend the service to a colleague.

However, not all businesses are acceptable to Groupon, which rejects seven of them for every one that it features. “That’s one thing that differentiates us from our competitors. We turn away businesses that don’t meet our quality parameters,” a Groupon spokesperson says, “which is why so many clones are springing up that take the leftovers.”

Group buying services aren’t for every business, and there are hurdles to be cleared before merchants can take advantage of the marketing mechanism. Retailers need to staff up the week of the deal, employees must be trained to redeem vouchers, and merchants need to take the opportunity seriously and prepare, the services say. Don’t put out an offer that you’re not capable of handling, they warn.

The Groupon spokesperson’s best advice to interested merchants is to visit GrouponWorks.com, a site designed to educate them about Groupon with webinars, case studies, demographics, and descriptions of some of the most successful deals so that businesses can structure their deals similarly.

“We’re structured so that, ultimately, the merchant’s success kind of rests in their own hands,” the Groupon spokesperson says. “People come to us for our extensive network of subscribers. But, then, if we’ve done everything right, if we’ve sent you the best customers possible, when they enter your business, it’s up to you as the merchant to continue the relationship, to ask customers for their email address when they check in or pay the bill, or to give them a card to fill out that gives you information to contact the customer in the future. We offer lots of suggestions but…it’s up to the merchant to follow through.”

She reports that some merchants follow Groupon’s suggestions, while others “just run their deal and don’t pay attention to the results. Our recommendation,” she says, “is that the more hands-on you are and the more analysis you do, the happier you’re going to be.”

To that end, Groupon offers an app, available in the App Store, that runs on devices equipped with cameras, such as the iPhone, iPad, and Android. Merchants that have downloaded the app can scan the coupons at the point of redemption, and the data gets transmitted to the merchant’s dedicated page on Groupon.com’s Merchant Portal.

“It’s our way of encouraging merchants to track their deal and see how redemption rates are going…and then, hopefully, to share that information with us,” the spokesperson says.

Meanwhile, competitor LivingSocial differentiates itself from Groupon by emphasizing the personal touch of its sales force. “We believe you should be able to shake the hand of the person you’re working with,” a spokesperson says, “which is why we have LivingSocial employees in every single one of our markets. Having people on the ground locally also gives us the advantage of knowing what’s hot within that community and the best way to work with each merchant to craft a deal.”

LivingSocial touts its Merchant Bill of Rights, which includes the right of every merchant to have a single point of contact whom they can call with questions or concerns. The business model is essentially the same as Groupon’s, but LivingSocial is a bit more forthcoming with its growth stats. LivingSocial released its first daily deal in July 2009 for the restaurant Zengo in Washington, D.C.’s Chinatown.

Almost two years later, LivingSocial is booking $1 million daily and is projected to exceed $500 million in revenue this year. It claims to have saved nearly 26 million subscribers a total of more than half a billion dollars in over 30,000 deals. In 2011, LivingSocial grew from six markets in one country with 120,000 members and just 33 employees in January to upward of 250 markets in 12 countries with 29 million consumers and 1,350 employees in April.

This past December, LivingSocial secured a $175 million investment from Amazon.com and an additional $8 million from Lightspeed Venture Partners, funds that are expected to help fuel LivingSocial’s growth and enable it to launch products—such as Escapes, Instant Deals, Adventures, and Family Edition—that provide family-centered daily deals. Escapes targets short-break travel opportunities; Instant Deals are good for just a few hours, compared with the more typical 24-hour daily deals; and Adventures are LivingSocial-produced multiple-vendor events, such as the recent “tubing and tasting” day. A bus drove subscribers from New York City to a ski resort for half a day of snow tubing followed by a stop at a microbrewery, where a master brewer led a tasting session. Merchants who would like to forge deals with LivingSocial can go to LivingSocial.com and visit the Businesses tab at the bottom for introductory information and a form that can be filled out to begin the process.

The cost of dealing with LivingSocial is almost identical to that of Groupon. One spokesperson says, “While we don’t go into the specifics of the deal mechanics, it would be safe to say that we’re running in the same ballpark as Groupon, but I can’t be more specific.”

Most of the businesses that use either Groupon or LivingSocial are small and lack both CRM systems and the resources to develop them.

As the LivingSocial spokesperson says, “It’s really up to the merchant to keep track of customers’ email addresses and how that customer fits into the merchant’s marketing plan. What we do is give the merchant names and voucher numbers through our password-protected Merchant Center, which is where they can go to track how the deal is doing. Then it’s up to them to figure out what works best for their business and how they want to create relationships and stay in touch with the LivingSocial members. We don’t help the merchant stay in touch with their customers.”

The spokesperson continues, “It used to be that local merchants would buy an ad in the Yellow Pages. They’d pay up front, and then it was really hard to tell whether anyone was motivated by the ad to come through their doors. Now, with this new marketing channel, it’s no money down, you can check as your deal goes live how many vouchers you’ve sold, and because you know they are coming in from LivingSocial, as they come in to redeem, that’s your opportunity to build your relationship with your customers. What could be better than that?”

That depends, says Sucharita Mulpuru, principal analyst at Forrester Research, who follows the industry. She believes the biggest reason for a merchant not to take part is “that it’s expensive, really expensive. To give up 50 percent as a discount on the merchandise and then to share an additional 50 percent of your revenue to the group buying service, that’s why many companies are leery about doing it—and are even more leery after they do it once and are considering whether to do it again. I’m sure they notice that, for example, they fill more tables at their restaurant, that there’s more volume, that there’s more utilization of their staff, and that’s fine as a gauge. But you also have to determine whether the deal is a money-loser or not. And often it is.”

That’s the reason some merchants are turning elsewhere, to ShopIgniter, for example, another player that offers a very different kind of service. ShopIgniter supplies cloud-based social e-commerce software that enables retailers to create their own group buying service for private sales on their own Web site—a sort of do-it-yourself product that eliminates the need to share revenue with a third party, such as Groupon or LivingSocial.

“Say a retailer wants to deliver a private sale on a new line of jeans that expires in 24 hours to create a sense of urgency,” says Matt Compton, ShopIgniter’s CEO. “And, say, the more people who buy the jeans, the lower the price. That’s a good example that employs three different aspects of the new retail model: It’s a private sale that only allows members or people who are part of a VIP group, it’s a time-based sale that has a clock on it, and it encourages people to share with their friends because the price goes down as more and more people participate. Our SaaS [software as a service] allows a marketer or e-commerce manager to create that sale, to add products into the sale, and to create the dynamics around the sale.”

Two-and-a-half-year-old ShopIgniter claims to have more than 100 customers who pay a recurring monthly fee that is tiered based on order volume: the bigger the order volume, the higher the fee.

“But on a per-order basis,” Compton points out, “the cost definitely goes down as the company grows. Our pricing starts at a few thousand dollars a month and goes up to tens of thousands of dollars a month. I’m afraid I can’t be more specific.”

In May, ShopIgniter announced a partnership with Web analytics company Webtrends to offer what ShopIgniter calls the first social e-commerce offering that has analytics.

“Why is that important?” Compton asks. “That is how retailers and brands can determine their most valuable customers. Customer A may purchase $1,000 worth of merchandise from a group buying promotion, but customer B might influence $10,000 worth of purchases. In that case, customer B is the more valuable, and a retailer can only know that by integrating analytics.”

According to Compton, the Webtrends/ShopIgniter offering will enable retailers and brands to:

• understand the effectiveness of Facebook stores in driving sales;• understand the reach and social influence of fans and friends of fans across their extended network;• measure and manage a fan rewards program to offer incentives and discounts to fans who share and drive their friends to the store; and• measure conversions against reward programs, promotions, and campaigns.

Compton points to Google’s offer to acquire Groupon for a reported $6 billion, Groupon’s subsequent rejection of that offer, and reports that surfaced in January that Google planned to launch a competing product, called Google Offers.

“For me, Google’s entry certainly validates the space and shows that this kind of retail model is going to scale out across the retailer universe; it’s really positive for the space,” Compton says. “From our perspective, the more retailers and brands are thinking about the value of these new retail models, the better. If they say, ‘Hey, this group buying or demand-based sales is something we want to do’…then that’s great for us.”

Facebook, too, is weighing the group buying space, having begun testing a social buying program in April. However, with more and more high-profile players jumping into the fray, what will it take to grow market share? According to Mulpuru, the answer will be CRM. “You know what is going to be the Groupon killer?” she asks. “Companies like Cardlytics and BillShrink and edo Interactive and Offermatic and Mint.com, companies that work with the banks that have the transactional data and can look at patterns in consumer spending.”

Such companies are running Groupon-like offers through credit cards that are relevant for specific merchants. In other words, if a merchant would like to target consumers in a specific ZIP code and would like to know who the shoppers are in that ZIP code who have patronized a competitor, that merchant can make that happen. Large group buying services cannot.

“The challenge is going to be for these companies to build large enough sales forces to come up with compelling offers every day,” Mulpuru says. “They’re not going to cut it if they have an offer every month or so. They need frequency, which is no easy feat. If they would combine with Groupon or with LivingSocial, that would be incredible. Then they’d be leveraging CRM with the power of the sales forces that the group buying services employ. To have that level of information and to fire up offers based on that, that is very, very powerful, and that, I think, will be the future.”